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Which is a better investment: residential or commercial property?
If you’ve ever read feedback or messages left behind on real estate forums, you’ve probably found most experts encouraging people to invest in residential properties. However, deciding between investing in residential or commercial real estate is not a decision that you should rush to make.
Investing in commercial or residential real estate has unique benefits and challenges. The path that you’ll take depends on your goals, liquid capital, risk tolerance, and time.
Before making a decision between commercial vs residential real estate investing, you need to understand how these two investment strategies work.
Differences between residential vs commercial real estate
Most people use these two words interchangeably because they are closely linked to each other. However, there is a difference between residential and commercial property.
Residential property is a single-family home comprised of one to four units. They include condos, quadruplexes, and duplexes.
On the other hand, commercial property is anything with more than four units. They include industrial, retail, hotel, multi-residential (five units and above), and special-purpose spaces.
Another difference between the two is the type of tenant that they attract. Residential properties are usually leased to individuals and families whilst commercial properties are leased to business entities.
Both types of properties come with different opportunities for the investor.
Residential properties give the investor an opportunity to play an active role while commercial properties award the investor with a wide range of investment opportunities.
Benefits of investing in commercial real estate properties
There are lots of benefits to investing in commercial properties. They include:
1. High returns
As the popular saying goes, the higher the risk, the higher the reward. Commercial property returns and far more attractive than those of residential properties.
A research study conducted by the National Council of Real Estate Investment Fiduciaries found that commercial real estate investments have an average return of 12.7 percent annually compared to residential properties which have an average of 8.8 percent.
More space attracts more tenants which results in more money in your bank account. This is one of the best choices for an investor who wants to diversify his or her portfolio.
2. Good tenants
It can be hard for investors with residential properties to find tenants who will look after the property like their own. On the other hand, commercial properties attract corporations and businesses.
Since the tenants are backed by their organizations, they are more likely to take good care of the property. Good tenants will make your life easy.
3. Long-term leases
Commercial leases are usually longer than that of residential properties. They normally start from six to twelve months.
If you ask around, you’ll find out that most properties have been leased anywhere from five to ten years. For the investor, this means lower vacancy rates and turnover costs.
Long-term leases are linked to reliability and positive cash flow. Commercial investors can end up dealing with undesirable tenants for a long time. However, they can avoid this by following the law and appropriate application processes.
4. Easy to increase value
One of the major differences between commercial and residential properties is how the property values are determined.
Residential real estate is greatly influenced by other similar properties while commercial properties are impacted by how much revenue they generate.
In short, the higher the revenue a commercial property generates, the higher the property will be valued. With qualified tenants, commercial investors will witness an increase in value faster than residential properties.
5. Triple net leases
Triple net leases vary depending on the situation. However, they are extremely important for investors with commercial properties.
A triple net lease ensures that the tenant handles all property expenses including taxes. All the investor has to pay is the mortgage.
Big organizations such as Walmart and Starbucks sign this lease to maintain the look and feel that goes hand in hand with their branding strategy. The tenants manage all other costs while the investor pays maintenance costs only.
There are different types of leases that you can adopt. However, a triple-net lease will accelerate your progress.
Benefits of investing in residential real estate properties
Here are some of the benefits of investing in residential real estate and properties:
1. Low entry cost
It is possible to obtain a loan to invest in commercial real estate. However, even for a beginner, the cost of investing in residential property is much lower than in commercial property.
Most people don’t have enough savings for a down payment on commercial properties. But they have likely saved enough over the years for a family home.
If you have been thinking of investing in real estate, the best way to begin is by purchasing residential properties. After a couple of years, you’ll have enough capital to invest in a commercial property.
2. Low tenant turnover
Residential real estate investors with single-family homes don’t have to deal with the issue of tenant turnover regularly.
However, unlike commercial properties, it can be difficult to keep good tenants for a long time. Investors have to work to find tenants regularly.
If you screen your tenants correctly, you will find individuals who are committed to staying with you in the long term. Focus on long-term tenants because they’ll treat your property like their own.
3. Lenient zoning laws
Zoning laws are strict for commercial real estate investors. The rules and regulations of residential real estate are lenient because they are smaller in scale.
4. A large pool of buyers and renters
We all need a place to live in. Residential real estate investors have the advantage of having a large pool of buyers and tenants, unlike commercial real estate which relies on corporations.
As companies shift to the digital space and employ remote workers, commercial real estate investors may have a hard time attracting tenants. Residential real estate will always be on-demand.
5. Better option during the crisis
Businesses are usually the first to experience the effects of an economic recession. And this can negatively affect commercial real estate investors.
Commercial property owners looking for tenants during an economic crisis may find marketing extremely challenging. Residential real estate is not immune to an economic crisis. However, housing will always be in demand whether there is an economic crisis or not.
As you’ve seen, both investment strategies have their pros and cons. It is important to review them and figure out which strategy aligns more with your core values.
Commercial and Residential loans
Banks usually distribute residential mortgages or loans to borrowers. Unlike residential loans, commercial mortgages are made to organizations.
It is also important for borrowers to sign as representatives of their business entities for tax purposes because the property has been zoned for business purposes.
Residential loans are less risky than commercial loans (for lenders). That is why most commercial loans have high-interest rates and shorter terms.
To qualify for a commercial loan, you have to have a business plan and a good credit score. Commercial lenders focus more on the projected cash flow of the property than residential lenders. They’ll want to know who’ll be paying the utilities and the maintenance required before approving the mortgage.
The terms and conditions between commercial and residential loans vary greatly. Homeowners finance their properties over a long time.
Although residential investors have a variety of options on the table, the time frame is excellent due to the long amortization period which leads to smaller monthly payments. Commercial loans normally range from five to twenty years. Commercial lenders can customize the repayment schedule for all borrowers.
Passive commercial real estate investing
Passive commercial real estate investing makes it easier for individuals to invest as limited partners with real estate companies. While an investor can become the owner of a commercial building, the amount of capital required makes it harder to enter this sector.
Rehabbing and wholesaling residential and commercial properties is a good strategy for those who want to make a living in real estate.
However, for investors who want to diversify their portfolio, they may get better results by analyzing these strategies and focusing on building a portfolio of real estate investments.
Choosing to invest in commercial or residential property is not easy since both of them have a unique set of advantages and disadvantages.
Both will help you move closer to achieving your financial goals. To make a good decision, figure out what you want to gain in the long run.
Think about your goals and go through all the investment strategies available. Doing a risk analysis will help you choose the most profitable method.